Opinion: State finances are still in the red, even as the economy is growing

Most states face deficits, and tax collections have fallen in 32 states

CSU Archives/Everett Collection

States are walking a tight financial line.

By

KilHuh

By most measures, the national economy is doing well. We have been in expansion for almost eight years, the unemployment rate is under 5%, the stock market has hit new highs, and personal income growth—while still slow—has turned positive since the Great Recession.

Take North Dakota, which just three years ago enjoyed record tax revenue from the extraction of oil and now faces a $1.4 billion budget shortfall: In fiscal year 2013, the state had $2 billion in reserve funds and ending balances, an amount sufficient to run the government for more than 300 days. However, as North Dakota’s tax revenue has steadily fallen—decreasing 36.7% since fiscal 2014—elected officials have been forced to tap these budgetary reserves, leaving the state with only 114 days of operating expenses in reserve. Even draining these savings hasn't solved North Dakota’s budget challenges, so the state is now poised to cut its workforce and funding for higher education to make ends meet.

It’s easy, perhaps, to dismiss North Dakota’s decline as the logical consequence of a state budget heavily dependent on a tax on natural resource extraction, known as a severance tax, which means the state experiences a significant revenue shortfall when the price of oil declines. But North Dakota isn't alone in its struggle.

Because there is no single reason that so many states are struggling to balance their budgets, there is also no single solution for helping them to recover.

For example, Connecticut—a state with a very different economic base—is also facing a budget deficit: State officials have projected a $56.2 million shortfall at the end of the current fiscal year, ballooning to $1.5 billion next year. These difficulties are a result of lower-than-expected revenue from the state’s personal income and sales taxes—which according to our research are Connecticut’s two most volatile revenue streams. In addition to variability in revenue collections, the state received less money than anticipated from the federal government and will spend more on public employee pension contributions.

Revenue losses aren’t always the product of a state’s economic makeup or performance; tax policy choices play a role as well. In Kansas, for example, legislators slashed personal income taxes in 2012 and 2013, and the state now faces a shortfall of about $270 million—which is projected to grow to more than $500 million for the coming fiscal year. Legislators in Florida and Ohio have cut taxes since 2009, even though neither state has fully recovered from the revenue losses they experienced as a result of the recession.

Economic conditions and population changes can also help explain why some states have fared worse than others. And because there is no single reason that so many states are struggling to balance their budgets, there is also no single solution for helping them to recover. The confluence of challenges that states face today, from increased spending on health care to the changes in consumer preferences—most notably a growing “sharing economy”—has created a great deal of unpredictability for state governments.

A new administration in Washington has also caused uncertainty for states, especially with the potential for federal tax changes. Forty states that collect personal income taxes link to the federal tax system, meaning that changes to the federal tax code could cascade down and have a varied impact on states’ tax systems and revenue. For example, a reduction in federal itemized deductions such as the mortgage interest deduction might increase the amount of taxes paid to some states. In addition, even the possibility of Congress lowering federal tax rates could give some taxpayers, especially high earners, an incentive to time their income and deductions to take advantage of the change in rates, creating additional volatility in state tax collections.

Many policy makers inside the Beltway are also working to change the nation’s health-care laws—a move that is almost certain to affect state budgets. From 2008 to 2015, federal health-care grants to states grew 55% in real terms to $381 billion. Modifications to the Affordable Care Act currently being discussed—including changes to Medicaid—would likely reduce this revenue. And many—if not most—states are unprepared to absorb these fiscal shocks to the bottom line.

How can states thrive in an environment filled with budget challenges and fiscal uncertainty? Under these challenging circumstances, they must not only balance their budgets each year but also take a long-term view. Specifically, state policy makers must use detailed data and analyses to consider historical trends and forecast the long-term consequences of their policy choices. Although many factors, such as stock-market performance and the price of oil are outside the control of elected officials, government leaders can better prepare for the next downturn if they budget for the long term.

Kil Huh directs The Pew Charitable Trusts’ work on state and local fiscal health.

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